Embattled El Paso Corp. reported Friday that it closed out the third quarter in the red, and will begin winding down its ailing energy trading business in an effort to resuscitate the company.

The Houston-based energy giant posted a net loss of $69 million, or minus 12 cents per diluted share, for the third quarter compared to earnings of $211 million, or 41 cents per diluted share, for the year-earlier period. The results included a loss of $36 million for the company’s discontinued coal operations, a charge of $22 million on asset sales and $193 million in non-recurring charges and income from discontinued operations.

El Paso’s per-share performance for the quarter was substantially below Wall Street’s consensus of 27 cents/share for the company, as reported by the research firm Thomson Financial First Call. The company’s stock continued to take a beating in the wake of the earnings’ report, falling by $1.34/share to trade at $7.86 late Friday.

Despite the third-quarter drubbing, El Paso reported it was financially healthier on a year-to-date basis, with a net income of $269 million, or 49 cents per diluted share, for the nine-month period, compared to a loss of $282 million, or (minus) 56 cents per diluted share, for the same period in 2001.

“While overall earnings were hurt by weak trading and refining results, our core businesses of pipelines, production, midstream and power produced strong earnings and cash flow in a difficult quarter,” said El Paso Chairman William A. Wise. “Our core businesses alone generated third-quarter earnings per share of approximately $0.33 after deducting 100% of our financing and corporate/other expenses. We are moving aggressively to rationalize our weaker businesses and are announcing today a plan to exit energy trading.”

Wise estimated the actual winding down of the energy business will take 18 to 24 months. The company could not say how many trading employees would be affected by the move, although sources indicated El Paso already has begun informing workers of lay-offs. “We’re evaluating that. We’re still in the developmental stages of our plan to exit that business,” an El Paso spokesman said.

As a first step, El Paso said it plans to liquidate its trading portfolio, which has a net asset value of $968 million, and separate the credit and balance demands of trading from the rest of the corporation by transferring the bulk of the portfolio to a new subsidiary, Travis Energy Services LLC. It said it has asked the major credit rating agencies to rate Travis Energy separately, and is seeking an investment-grade rating for Travis.

El Paso said it expects to finance the liquidation of Travis Energy’s trading portfolio by obtaining credit facilities valued at approximately $600 million. The company noted it currently is actively negotiating with lenders to provide the funding, and intends to pledge the cash flow from liquidating its trading portfolio and 50% stakes in Citrus Corp., which owns Florida Gas Transmission, and Great Lakes Gas Transmission as collateral for the $600 million in credit.

The response of the credit rating agencies to El Paso’s plans to exit trading “has been very positive,” Wise told industry analysts during a conference call Friday.

The company reported its energy trading operations contributed $336 million less during the third quarter than in the comparable period last year, largely due to the credit concerns in the market and the new prohibition against mark-to-market accounting of certain energy contracts. Without the accounting change, trading would have posted an additional $96 million in earnings during the quarter, El Paso said.

El Paso did not provide revised earnings and cash flow guidance for the year and 2003, saying it will do this after it completes its annual budget process and a review of the impact of the new accounting rules on energy contracts within six weeks. Wall Street analysts have projected average earnings of $1.96/share for the company in 2002, but it’s unlikely El Paso will meet that target.

The company put its available cash liquidity at $4.5 billion, including $1.3 billion of immediately available cash, a $3 billion, 364-day bank revolver and a $1 billion multiple-year bank revolver. El Paso said it has “announced or completed” $3.6 billion of asset sales so far this year, and expects to exceed its target of $4 billion by the end of the year.

On a segment basis, El Paso’s pipeline group saw earnings before interest and taxes (EBIT) rise 11% to $302 million in the third quarter from $274 million for the comparable period in 2001. The company credited the increase to its expansions, reactivation of the Elba Island liquefied natural gas (LNG) facility, lower operating expenses and a $14 million favorable resolution of a processing issue. It noted that all of its pipelines had solid increases in throughput during the quarter, with the exception of El Paso Natural Gas, which experienced an 11% decline due to a sharp reduction in gas demand from California power generation plants this year.

Despite a drop in production, El Paso’s production operations had an EBIT of $179 million for the third quarter, up from $169 million for the same period a year ago. The 2001 results were negatively affected by a $135 million ceiling test charge and a $3 million merger-related charge, the company noted. Third-quarter production fell 14% from 2001 levels due to the sale of about 1 Tcf of natural gas equivalent proved reserves during the first nine months, as well as the loss of some wells in South Texas and shut-in production due to Hurricane Isadore.

The company said the realized price for gas dropped to $3.21/Mcf during the third quarter from $3.46/Mcf a year ago, while the realized price for oil, condensate and liquids rose to $22.19 per barrel from $21.62. It noted it has hedged approximately 50% of its expected gas production for the fourth quarter of this year at the New York Mercantile Exchange (Nymex) price of $4.15/Mcf, 38% of expected 2003 production at the Nymex price of $2.70/Mcf, and 13% of expected 2004 production at the Nymex price of $2.70/Mcf. It said it expects the realized price for gas to be 35-40 cents less than the Nymex per Mcf price due to transportation costs and regional price differentials.

El Paso’s Field Services’ operations posted a third-quarter loss of $11 million, down from $43 million in EBIT for the comparable period a year ago, due mostly to a $48 million loss on an asset sale. It noted that gathering and transportation rates improved during the quarter as a result of the sale of Field Services’ Texas intrastate gas transmission system to El Paso Energy Partners. However, gathering and transportation volumes fell significantly to 2,209 BBtu/d from 6,177 BBtu/d during the third quarter of 2001. In addition, processing volumes dropped to 3,883 BBtu/d during the third quarter of this year from 4,551 BBtu/d a year ago.

The Merchant Energy Group saw a third-quarter loss of $171 million compared with an EBIT of $253 million for the comparable period in 2001, reflecting lower income from trading and petroleum refining activities, as well as the change in the rules for mark-to-market accounting of certain energy contracts.

Also dragging down the corporations’s overall earnings has been a high-profile complaint case pending at the Federal Energy Regulatory Commission, where an agency judge has found that El Paso Natural Gas withheld substantial amounts of capacity from California during the state’s energy crisis to ratchet up gas prices. FERC has scheduled oral arguments for Dec. 2 so both sides — El Paso and the California Public Utilities Commission — can argue the merits of the case before the full Commission.

Asked if he personally will argue El Paso’s case, Wise said, “I think that that’s still being discussed, but that’s not likely.” He assured analysts that “no matter” how FERC decides the case, it will be headed for the U.S. Court of Appeals in the District of Columbia.

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